You finally decided on an architectural style and school district with your partner, and you’re ready to take the plunge on your first home. Your credit, income and assets check out. But as you start exploring financing, you realize that you need to put down a healthy down payment but haven’t been able to save up the cash. (We share tips on how to determine the exact amount here.)
There are a variety of options to explore when sourcing your down payment, many which a first-time home buyer may not be aware of. It’s critical to know the implications of each and how they can affect you in the long-term.
You can settle on a purchase price with the seller; then go back to them with a higher revised offer, asking them to credit back the difference as a closing cost credit to help lower your cash to close. Similarly, you can take a slightly higher interest rate and have the lender credit back some money towards closing costs. While this cannot be used towards down payment – only closing costs, prepaids, and such, it can help you apply more of your available funds toward the down payment rather than closing.
Avoid Personal Loans
Government sponsored enterprises (GSEs) such as Fannie Mae, Freddie Mac, and HUD, which ultimately may buy a loan once it’s complete, do not allow for borrowed down payments. If you are unable to demonstrate a pattern of savings to accumulate even a small down payment, then you’re considered a higher risk and not a prime candidate to be a homeowner.
The thinking here is that owning a home inevitably has unforeseen maintenance expenses and life can always throw you a curve ball with a loss of job or illness. If someone hasn’t demonstrated an ability to save for a down payment, then they are unlikely going to be in a position to keep the home they buy during the first rough patch they run into.
Respecting regulations is key: if you borrow your down payment and claim it to be a gift that you eventually repay – then you’ve committed fraud.
Personal loans that show up on your credit report are treated like any other debt that shows up on your credit report. However personal loans obtained from private parties such as friends and family are not going to show up on your credit report.
Auntie Sue Said She’d Help
Obtaining a true gift for either all or part of the down payment that doesn’t need to be paid back is not something everybody has access to, but a great alternative if you have family members that are able to provide this level of support. If the gift is for less than 20% then the borrower must have 5% of their own funds in the transaction on Fannie Mae loans.
A gift can be provided by a relative, which means a spouse, child, or other dependent, or by any other individual who is related to the borrower by blood, marriage, adoption, or legal guardianship; or a fiancé, or even a domestic partner.
It is important to note that the donor may not be, or have any affiliation with, the builder, the developer, the real estate agent, or any other interested party to the transaction.
I Don’t Want to Owe a Favor
If you personally don’t have the down payment saved up or somebody willing to provide a gift, you could:
- Borrow from your 401k, or cash out an IRA, etc. But be aware to consult your tax professional or financial advisor to understand what this means both short and long term.
- Apply through a down payment assistance program. These programs have special exemptions for being able to lend you your down payment and sometimes your closing costs in the form of a second or third mortgage. There are also income restrictions.
- If you’re self-employed sometimes you can use business assets towards your down payment if your business can withstand the withdrawal.
Employer assistance is yet another option, and may come in the form of a grant, a direct, fully repayable second mortgage or unsecured loan, a forgivable second mortgage or unsecured loan, or a deferred-payment second mortgage or unsecured loan. A borrower of a mortgage loan secured by a principal residence may use funds provided by an employer to fund all or part of the down payment or closing costs subject to minimum borrower contribution requirements.
Employer assistance can also be used for financial reserves for all types of assistance with the exception of unsecured loans (which may only be used for the down payment and closing costs). Employer assistance funds are not allowed on a second home or an investment property and funds must come directly from the employer, including through an employer-affiliated credit union.
Yet another avenue to consider is a Lease Option. In a lease-option, a property owner and tenant agree that, at the end of a specified rental period for a given property, the renter has the option of purchasing the property.
Rent credit for option to purchase is an acceptable source of funds and is determined by calculating the difference between the market rent and the actual rent paid for the last 12 months. The market rent is determined by the appraiser during the appraisal for the property being considered.
It is worth noting that under no circumstances may credit card financing be used for the down payment- same with signature loans and overdraft protection on checking accounts.
Do Your Homework
In the end, there are a variety of ways you can fund a down payment at different levels. Remember that by reaching 20% down you can avoid the extra monthly cost of mortgage insurance. Regardless of the amount that’s right for your financial situation, make sure you explore your options and what they mean for your larger financial profile, relationships, and long-term costs.
And if you need to discuss them in more detail, your Neat Capital loan advisor is here to help.